Cash In on Freeport’s Sweetened Plains Deal

What started out as bum deal for shareholders may actually end up being a big win over the long haul.

Back in 1994, after much in the way of investor saber rattling, Freeport-McMoRan Copper & Gold (FCX[1]) spun off its energy assets into McMoRan Exploration (MMR[2]).

Then, a few months ago, the world’s largest copper miner shocked the metals and mining investment community. How? Well, Freeport decided was time to bail out its struggling friend — along with buddy Plains Exploration & Production (PXP[3]) — and move back into energy production once again.

However, the deal didn’t sit too well with existing shareholders[4].

Investors complained pretty intensely about the Freeport energy deals … but they may have less to complain about here in the future. See, the copper and gold miner has agreed to pay additional special dividends to Plains shareholders in order to win support for the takeover.

For investors, the special dividends offered may just be enough to get things moving in the right direction.

The new terms will[5] give current Plains shareholders a one-time, $3-per-share dividend before the previously announced transaction closes. After that, Freeport will pay shareholders in the combined company another $1 per share.

Overall, the extra special cash dividends raise the value of the deal to $6.6 billion.

That’s certainly a welcome sign considering the already-heated acquisitions became even more so over the last few weeks.

During the initial conference call to discuss the deal, analysts and shareholders questioned the wisdom[6] of one of the world’s largest metals miners moving back into a business it left behind years ago. Many investors typically use FCX as a proxy for copper since its revenues are so heavily tied to the metal.

Additionally, investors were concerned that the deal will be a huge distraction from a mining operation that has been performing well since the original spin-off. They thought moving into the energy would ultimately throw Freeport’s investing thesis completely out of whack.

These fears were compounded when global commodity prices began “puking-out[7]” a few weeks ago. Freeport’s two key products have been some of the hardest hit natural resources. Investors fled gold’s safe-haven status for equities, while copper prices dwindled on soft demand in key consumer China. Those failing prices also put a dent in Freeport’s share price, which was a key piece in the Plains deal.

The original terms had Freeport purchasing the E&P firm for 0.6531 share and $25 in cash. Back on Dec. 5 — when the deal was first announced — that combo was worth about $50 a share. The value of the bid tanked as Freeport shares declined in response to falling commodity prices.

Needless to say, the declining value of the bid didn’t exactly make grumpy shareholders any happier.

Taken as a whole, though, the additional cash that Freeport is chucking in order to woo PXP shareholders will bring the deal back up to that critical $50 mark. And that newly expanded deal makes things interesting for investors — really interesting.

Why? Well, first off, the addition of energy assets into Freeport’s mix can be seen as welcome sign and will hopefully remove plenty of the volatility from the company’s earnings[8]. While copper prices have hit their lowest point in about a year and gold prices have fallen, oil and gas prices have increased steadily. That certainly adds some validity to Freeport’s thinking and makes the acquisitions accretive for the miner rather than dilutive.

In fact, FCX now will be on par with multi-commodity firms like BHP Billiton (BHP[9]) and Rio Tinto (RIO[10]). As we’ve seen from these two natural resource giant’s earnings, their wide variety of production has allowed them to benefit from the full commodity cycle. (While shale gas is down, iron ore is up … and so on.) That reduces lumps in profits and earnings.

Plus, the deal also strengthens Freeport’s dividend story[11].

Already, FCX has some pretty decent cash flows and a sector-high 3.9% yield. The supplemental dividend — which is conditional on the closing of the transaction — will be the eleventh special dividend Freeport has paid since 2004. That extra buck basically bumps FCX to a huge 7% dividend this year.

And there’s plenty of reason to think those special dividends will keep coming.

While it is taking on some debt to make the two buy-outs, Freeport’s cash flows should be strengthened by the addition of Plains’ various producing wells, along with the planned selling of around $1.5 billion in non-core assets. That asset selling will be more than enough to cover the additional dividend. Meanwhile, Freeport has pledged to reduce CAPEX spending[12] to chip away at its debt load over the next three years.

For the most part, these two factors makes Freeport’s purchase of Plains more palatable for current and future shareholders. The commodity markets are a fickle mistress and FCX’s new strategy of diversifying away from just mining may be the best decision over the long run.

With that in mind, buying shares of Plains before the deal closes could be a great move for investors.

As of this writing, Aaron Levitt did not own a position in any of the aforementioned securities.